3) Investing 101: Types of Investments

by · August 23, 2010

In this part of the tutorial, we will discuss several ways to invest your money.  Knowing the characteristics of the types of investments and how each one is suited for a particular investing objective will help you decide which investment vehicles are suited for you.

Bonds

This type of investment generally falls under the category of fixed-income securities. A bond is commonly used to refer to any securities that are founded on debt. Thus bonds are similar to loans.  It is a formal contract to repay money that is borrowed at a fixed interval over a period of time and with interest.

When you purchase a bond, you are actually lending out your money. In return, the debtor is obliged to pay the principal plus interest as specified in the terms of the bond. Bonds must be paid in fixed intervals over a period of time until maturity. Generally, bonds are issued by corporations and governments.  The issuer of the bond is called the borrower or debtor, and the holder of the bond is the lender or creditor.

The main advantage of bonds is its relative safety and stability.  If you buy bonds from a stable government, your investment is virtually guaranteed, or risk-free, but it comes at a cost.  The potential return of a bond is diminished due to the little risk involved.  The rate of return of a bond is normally lower than other securities.

Stocks

A stock represents the capital invested into a business. The term stocks, or stock, is commonly used as a synonym for shares. If you buy stocks, you are buying a share of the company, thus you become a part owner of the business. As part owner, you will receive any profits, also known as dividends, that the company allocates to its shareholders.  Depending on the kind of stocks you purchased, you are normally entitled to vote at a shareholders’ meeting.

Compared to bonds which are generally considered safe and stable, stocks are risky and volatile. There are usually no guarantees when buying stocks and they are known to fluctuate in value on a daily basis.  In fact, you must assume the risk of losing some or all of your investment. Although stocks are risky, the potential return is relatively higher compared to bonds.

Mutual Funds

A mutual fund is a type of collective investment plan that is managed by a professional. When you purchase a mutual fund, you are pooling money together with other investors as a group. The professional manager’s job is to select specific securities for the group. Mutual funds are all set up with a specific strategy in mind, and their focus can be nearly anything from stocks, bonds, other mutual funds, money market instruments, other securities and commodities, or a combination of any of these.

The main benefits of a mutual fund is that you can invest your money without so much the time and experience that are regularly needed to choose a sound investment. With the help of a professional managing the investment, it is believed that the investors of a mutual fund have a better return on their investment, although this does not come without some risks involved.

Alternative Investments

An alternative investment is something that does not fall under the category of the two basic securities: stocks and bonds. While most investments are categorized under the basic securities, also called traditional investments, there are alternative investment vehicles which are more complicated and involves a more advanced investing strategy.

Common examples of alternative investments are options, futures, FOREX, precious metals (e.g., gold and silver), and real estate. Private equity and hedge funds are also considered as alternative investments.

For new investors, it is not advisable to put your money in alternative investments. The promise of big profits in this type of investments also involves a high risk and requires specialized knowledge on the part of the investor.